December 14, 2010

Bond Markets Show a Welcome Decline in Fear and Panic

Martin Wolf:

Why rising rates are good news: Terrified by irresponsible fiscal and monetary policies, the bond market vigilantes are out in force. So rose the cry, as rates on government bonds jumped last week. Alas for the panic-mongers, this glib story is nonsense. What is happening is a move towards normalisation. That is excellent news. Policy is working. That does not mean it could not be improved. But what is astonishing is not how high nominal and real interest rates have become, but how low they remain. They are likely to rise substantially if and when less abnormal conditions arrive.

What has happened? Between November 30 and December 13 2010, the yield on 10-year US government bonds jumped by 0.49 percentage points.... Are these jumps significant? No. In the case of the US, rates are back where they were in June 2010, before the marked fall in optimism about economic prospects....

To understand what is going on, we need to distinguish the role of shifts in real interest rates from that of shifts in inflation expectations. Fortunately, inflation-indexed bonds allow us to do just that. In the US, the recent rise in nominal rates is explained almost entirely by the rise in the real rate, not by a rise in implied inflation expectations. To be precise, the rise in real rates turns out to explain 76 per cent of the jump from November 30 2010 and 83 per cent of the jump from November 4 2010.... Do these jumps in long-term interest rates mean that the Fed’s quantitative easing programme has failed? Absolutely not. The Fed’s aim is to make rates lower than they would otherwise be and so raise economic growth and eliminate any threat of deflation. Rates are still remarkably low. They are rising because of a jump in real rates that almost certainly reflects improved prospects for growth. I would imagine that the Fed is pleased with the picture it sees before it....

Are long-term interest rates likely to rise still further? Definitely....

In all, what has happened in bond markets is encouraging. Rates are rising, as depression psychology dwindles. With luck, the recovery is going to take hold. Hurrah!

Comments

Bond Markets Show a Welcome Decline in Fear and Panic

Martin Wolf:

Why rising rates are good news: Terrified by irresponsible fiscal and monetary policies, the bond market vigilantes are out in force. So rose the cry, as rates on government bonds jumped last week. Alas for the panic-mongers, this glib story is nonsense. What is happening is a move towards normalisation. That is excellent news. Policy is working. That does not mean it could not be improved. But what is astonishing is not how high nominal and real interest rates have become, but how low they remain. They are likely to rise substantially if and when less abnormal conditions arrive.

What has happened? Between November 30 and December 13 2010, the yield on 10-year US government bonds jumped by 0.49 percentage points.... Are these jumps significant? No. In the case of the US, rates are back where they were in June 2010, before the marked fall in optimism about economic prospects....

To understand what is going on, we need to distinguish the role of shifts in real interest rates from that of shifts in inflation expectations. Fortunately, inflation-indexed bonds allow us to do just that. In the US, the recent rise in nominal rates is explained almost entirely by the rise in the real rate, not by a rise in implied inflation expectations. To be precise, the rise in real rates turns out to explain 76 per cent of the jump from November 30 2010 and 83 per cent of the jump from November 4 2010.... Do these jumps in long-term interest rates mean that the Fed’s quantitative easing programme has failed? Absolutely not. The Fed’s aim is to make rates lower than they would otherwise be and so raise economic growth and eliminate any threat of deflation. Rates are still remarkably low. They are rising because of a jump in real rates that almost certainly reflects improved prospects for growth. I would imagine that the Fed is pleased with the picture it sees before it....

Are long-term interest rates likely to rise still further? Definitely....

In all, what has happened in bond markets is encouraging. Rates are rising, as depression psychology dwindles. With luck, the recovery is going to take hold. Hurrah!